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Today I’m writing about “My Scariest Money Mistake and What I Learned From it” for the Yakezie Blog Swap. A group of Yakezie Finance and Lifestyle Network members all write about the same topic on another website. Check out all of the contributors (at the end). And be sure to visit Barbara Friedberg Personal Finance for Crystal’s post!
The mid 2000’s were a golden era in the U.S.A. Interest rates were low, there were enough jobs to go around, and investment values were trending upward. Finally, there was hope that all American’s could finally own their own homes.
The American Dream Turned into a Nightmare
Mortgage companies were thrilled with the abundance of capital and low rates and began giving out mortgages like candy. If a buyer didn’t have enough income to qualify for the loan, no problem, the mortgage company tweaked the numbers a bit! Their consciences were clear as they believed that home appreciation would up the principal value of the borrowers home. And, the mortgage companies sold the loans they made so if there were a few loans going out to unqualified buyers, it would soon be someone else’s problem.
All of these mortgage loans were repackaged by investment banks along with Fannie Mae and Freddie Mac, the “reputable” quasi government agencies. These repackaged loans were combined into marketable securities called collateralized debt obligations (CDO), similar to bonds and sold to the public.
Sounds great doesn’t it? Anyone can get a home. Investors have lots of great new bonds in which to invest.
The Investment Markets Tanked
The belief that home prices only go up was slammed. In 2006 home prices began to decline and by 2008, values were dropping at a level not seen since the Great Depression.
When home values fell, home owners who wanted to sell were facing prices lower than their mortgage amount and the prospect of big losses. Many homeowners defaulted on their loans and lost their homes. Others faced growing mortgage payments as their adjustable rate mortgages increased.
On top of this debacle, those wonderful CDO bonds were mis-rated by the trusty investment rating agencies. Investors thought they were buying top rated debt when in reality, the underlying mortgages in their CDO’s were defaulting. This caused the investor’s bonds to decline in value. Since no one really knew the worth of the underlying investments in the CDO bonds, their values tanked.
The once rosy economic picture became bleak. Homeowners lost their homes and investors lost money on their investments and investment banks went under or faced government bail outs.
In 2009, as the housing market tumbled and the S & P 500 Stock Index fell from a high of 1549 in August, 2007 to a low of 735 in February, 2009, the country sank into a recession. Investors, homeowners, and consumers were scared!
No one with money in the stock market was spared.
Fear Took Over in the Markets – I Stayed the Course
Investors did not believe that the financial institutions knew the true value of the bonds they were issuing or the extent of their own corporate losses.
Investors panicked, sold their investments, ran for the hills and the financial markets crashed.
During this period, I did not panic, nor did I sell. As the overall markets fell, so did my portfolio!
Although the S & P 500 dropped 50 percent; due to a diversified portfolio, I only lost 30 percent of our family’s investment portfolio.
Many investors got really scared and sold-at the bottom! This was not a good idea! I was freaked out, and scared, but knew my market history. Luckily, having invested for decades and studied finance and investing, I knew history was on my side. I remember hearing lots of folks talking about pulling out of the markets completely!
I knew that was the wrong approach. After all, when you pull out, how do you know when to get back in. You are much more likely to miss out on potential future gains if you sell.
How I Increased our Portfolio 160% Over the Next 5 Years
I believe in the strength of not only the U.S. Industries, but also the global marketplace. Although I was upset, scared, and worried about the value of our families assets going down. I did not panic. I used my knowledge to hold on.
Then I did something counter intuitive.
During the market lows in 2009, I took some of our cash assets and plowed more money back into a diversified pool of index mutual funds. While many people were scared, I figured the valuations were so low, that even if they fell a bit more, they were likely to rebound eventually.
I followed my own advice and maintained a diversified asset allocation in line with my risk tolerance. When the stock investments fell in value, I rebalanced by investing more in the underperforming asset classes. And then I went in even deeper by investing more cash especially in Real Estate Investment Trust (REIT) index funds, because those funds in particular got clobbered during the mortgage meltdown.
I was scared and nervous when our assets fell. But I remained rational and acted on years of investing history and financial background. Could I have been wrong? Absolutely, history does not need to repeat itself.
Fortunately, my confidence in world markets was well placed.
The Financial Lessons Learned
- Do not follow the crowd.
- Do not panic.
- Create a sensible investing plan, preferably investing in diversified low cost index funds, and stay the course.
- Investments go up and down, stay the course.
- If you are far from retirement (or needing the invested monies) then continue to invest through down markets, because that is when the greatest profits are made.
- If investing declines are intolerable for you, put a small percent of your investable assets in stock type investments, because their prices go up and down!
This wasn’t really a money mistake, but a scary financial scenario. By remaining calm and sticking with a sensible investing plan the inevitable fluctuations in the stock market didn’t ruin my financial future.
Barbara Friedberg, MBA, MS is a portfolio manager, former university finance instructor, author of How to Get Rich; Wealth Building Guide for the Financially Illiterate, and owner of Barbara Friedberg Personal Finance.com.
Image credit; Yahoo Finance
Participants in the Yakezie Blog Swap
- Mighty Bargain Hunter
- Money Smart Guides
- The Money Principle
- Debt Round Up
- Little House in the Valley
- Fat Guy Skinny Wallet
- Budgeting in the Fun Stuff
- Barbara Friedberg Personal Finance